Will cutting LTCG tax on equities bring foreign investors back?
Will cutting LTCG tax on equities bring foreign investors back?
In today’s Finshots, we explain why foreign investors are pulling money out of India and whether cutting taxes on their profits can help bring them back.
The Story
The hot discussion in the market right now is that taxes on equities are too high, and that is why foreign investors are pulling money out of India.
To put that in perspective, foreign investors have pulled out over ₹3 lakh crore from the Indian equity market so far in 2026, of which about ₹44,100 crore went out in October alone. This has worried many analysts and market experts because India needs foreign money to fund its current account deficit (CAD). In simple terms, that means paying for imports, which often exceed exports. So, some believe that cutting or even scrapping the long-term capital gains (LTCG) tax on equities could help bring some of that money back.
But is that really the case?
Well, let’s take it from the top and start with how LTCG tax on equities has evolved over the years.
For the uninitiated, LTCG is the profit you make when you sell listed shares or equity mutual funds after holding them for more than a year. Until 2004, these gains were taxed at 20%, but investors could use the benefit of something called indexation. This let them adjust their purchase cost for inflation, which shrank their taxable profits.
After that, LTCG on equities was exempt from tax for a long time. But there was a catch. The government introduced a tax called Securities Transaction Tax (STT), which you pay whenever you buy or sell securities such as shares, derivatives or equity-oriented mutual funds, regardless of whether you make a profit or a loss. Your stockbroker or mutual fund house collects it directly from you and remits it to the government.
But then, in 2018, the government also reintroduced LTCG tax on equities at 10% on gains exceeding ₹1 lakh. And in 2024, it raised the rate to 12.5% on gains exceeding ₹1.25 lakh.
The problem, according to those calling for tax cuts, is that investors now have to pay both LTCG tax and STT on equities. That feels like a double whammy. STT is currently charged at a relatively low rate of 0.1% on shares and anywhere between 0.001% and 0.15% on other transactions, such as futures, options and intraday trades. And while these rates may seem small, they were much lower earlier and have gradually increased over the years. So, they want the government to reduce or scrap one of these taxes.
But to understand whether that would offer any real relief, we need to look at two things:
1. What makes foreign investors put money into Indian equities or pull it out?
2. What does history tell us about lower taxes on equities?
Let’s start with the first question. Foreign investors move money in and out of markets for several reasons. They look at the returns they can earn in a country compared with what they could earn back home. They also consider currency movements, stock market valuations and whether exciting new industries are emerging. Think of the recent AI boom in some markets. Taxes are another factor, but they aren’t necessarily the most important one.
To understand why, consider mature markets such as the US. When federal, state and local taxes are combined, the tax on long-term capital gains from equities can exceed 35%. That’s a lot higher than India.
Also, investors generally account for taxes when deciding where to invest. So a small change in the tax rate affects how much they keep after paying taxes, but it may not be enough to make them abandon a market altogether.
There’s some evidence to back this up. In 2024, India increased the LTCG tax on equities from 10% to 12.5%. If taxes were such a big concern for foreign investors, you’d expect them to pull money out of Indian equities, right?
But that’s not what happened. A BusinessLine story points out that foreign investors poured ₹1.77 lakh crore into Indian equities in 2023. In 2024, that figure rose to ₹2.08 lakh crore. In fact, even after the LTCG tax increase in July 2024, they invested another ₹61,471 crore in equities during August and September.
So then what explains the recent exodus?
See, for the past few years, especially since the pandemic, Indian equities have been an attractive destination for foreign investors. During the pandemic, global interest rates fell to very low levels, almost zero in the US. Governments also pumped money into their economies through stimulus measures. This gave investors access to cheap money, which they could put into emerging markets such as India.
At the same time, interest in India’s stock market surged. More people became financially aware and started investing, while the excitement around IPOs attracted money from investors hoping to make quick gains. Stock valuations soared, with some companies trading at as much as 100 times their profits.
But things have changed now. Global crises and rising oil prices have put pressure on the Indian rupee. Meanwhile, stock valuations are correcting, leaving investors with fewer opportunities to make big profits. And when safer investments at home, such as government treasury bonds, offer reasonable returns, foreign investors may prefer those over riskier investments abroad.
Another reason is that a weaker rupee can create a tax problem for foreign investors, even when their investments haven’t actually gained value in dollar terms. For example, suppose a foreign investor buys Indian shares worth $100 when the exchange rate is ₹95 to a dollar. Their investment is worth ₹9,500. Now imagine the share price doesn’t change, but the rupee weakens to ₹96 to a dollar. The same shares are now worth ₹9,600 in rupee terms, even though they’re still worth $100 in dollar terms.
So, the investor hasn’t made any actual gain in dollars. But the investment’s value has increased by ₹100 in rupee terms. If they sell the shares, that ₹100 could be treated as a capital gain for tax purposes.
Meanwhile, other Southeast Asian markets have also attracted investors riding the AI boom (although that bubble seems to have already begun to burst in China.).
Clearly, foreign investors have several reasons to pull money out of Indian equities and taxes are only one piece of the puzzle.
This means cutting or scrapping LTCG tax may do little to bring them back. Besides, some foreign investors already pay little or no tax on these gains because of tax treaties between India and their home countries. Which means they may not benefit from a tax cut at all.
What the government could lose, however, is a substantial amount of tax revenue. And if that money stops coming in, the government may have to make up the shortfall through other taxes. That could mean a greater burden on people like you and me, who pay taxes on salaries or business income, or on companies.
Sure, you might argue that stock markets have been flat or falling lately, so the government probably isn’t collecting much LTCG tax on equities anyway. After all, if investors aren’t making profits, what is there to tax?
But here’s the thing. Vivek Kaul, in a beautifully written story, pointed out how LTCG on equities have gone up from ₹29,200 crore in FY19 to ₹1.29 lakh crore in FY25. So naturally, the revenue the government collects from this has also increased over the years, helping it fund its spending during periods of economic uncertainty.
So, even if you and I aren’t making money in the stock market, foreign investors clearly are. And cutting taxes for them may not be enough to make Indian equities attractive again.
What a tax cut could do, instead, is nudge more domestic investors into the market. That’s because taxes on equity investments are still much lower than taxes on things such as fixed deposit interest or salaried income.
But alas! Money invested by domestic investors can’t replace the dollars India needs to pay for its imports and other foreign expenses.
Until next time…
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